Delay in floating Sukuk bonds hampering SBP monetary policy


KARACHI (May 07 2007): Non-issuance of sovereign Islamic bond (Sukuk) in Pak currency by the government is hampering the State Bank of Pakistan''s ability to intervene in the money market and weakening its monetary transmission mechanism. Pakistan has floated Sukuk dollar instruments as well as private issues in rupees from the government-managed institutions.

But somehow Islamabad''s plans for sovereign Sukuk issues have bogged down despite the establishment of the first Islamic bank five years ago. The size of the deposits in half a dozen of the Islamic institutions concerned has crossed Rs 85 billion and these banks have been clamouring for Shariah compliant government paper in order to develop their liability side.

Nearly all of the conventional banks have also opened Islamic banking windows (exclusive branches) and they too are facing difficulty in developing their lending business based on Shariah compliant instruments. They are reportedly placing these Riba free deposits with Islamic banks on 4 to 6 percent returns. And, these Islamic banks are lending at 9.50 percent to their customers, mainly in commodity financing.

The SBP has also not been able to sterilise the dollar deposits in Islamic banks, as Shariah does not allow rupee-dollar swaps. And the frequent OMOs held by SBP to suck liquidity from the system, when needed, has had no impact on Islamic banks as they are outside the system and SBP has no instrument to interact with them.

VOLATILITY: SBP has been able to control the volatility in the interbank market by not allowing the overnight rate to drop below 7 percent and restricted its movement in the range of 150 basis points as against 500-600 bps sometime back.

The gap between the Kibor rate and T-bill rates had increased after the raising of CRR and discount rate in August last year as against 75 to 80 bps before that. After touching a high of 120 bps in January the gap has once again narrowed between secured and unsecured lending at 75/80 bps for six months tenure.

Despite vocal protest on the sudden rise in lending rates by 8 to 9 percent, growth in private sector credit is around 12.6 percent (on April 24th, 2007) as against 20.2 percent in the corresponding period a year ago. It is expected that for the full year private sector credit will expand by 14 to 15 percent. With inflation at 7.5 and GDP growth of 7 percent, the rise in private credit will be near the nominal rise in GDP.

The big issue for the monetary authorities remains the volatility in government borrowing from the banking system. The government appears contented if its borrowing on a particular date (end quarter) and at the end of the year remains within the target.

This satisfaction, say money market analysts, is misplaced, as the volatility in government borrowing impacts monetary policy. "When SBP conducts a two week OMO with the aim to keep liquidity at a certain level, and, then the government all of a sudden borrows a big amount, within this two week period, SBP is compelled to create T-bills (money printing). This dilutes the monetary effort to control inflation. At present, money supply has risen by Rs 173 billion and budgetary borrowing is around Rs 121 billion.

Signals emerging from SBP''s fortnightly treasury bills auction clearly suggested that the Central Bank was reiterating its stance of tightening by hiking T/bills yields, though only by few basis point, as it has lifted yields on previous three occasions. Hence, the message was clear that the bias is still towards tightening.

So far the Central Bank has successfully managed to drain excess liquidity because of the rupees generated from Foreign Direct Investments (FDI) and home remittances, amounting to Rs 15-20 billion per month and has not allowed it to spill over and force the lending rates downward. But evidence is emerging that managing excess liquidity in the banking system is no more the easiest part of the job.

To sterilise the current size of available liquidity in the banking system, the SBP has very few options up its sleeves. Auctioning of T/Bills and PIB''s and mopping through open market operation (OMO) may not be enough to halt the flow of funds. The Central Bank has to make adjustments through Cash Reserve Requirement (CRR).

If you look around the globe, from Iceland to New Zealand, liquidity and inflation are posing a big challenge to the central banks globally. It''s a great challenge to maintain growth, manage excess liquidity and simultaneously contain inflation; so the two options frequently used, are either hiking interest rate or jacking up the reserve requirement.

An executive heading the credit portfolio of a large private commercial bank said, "There can be an argument that since SBP has adopted a tightened monetary stance and hiked rates, credit to private sector will not be meeting the FY 2006-07 target. The ambitious credit plan target of Rs 390 billion is likely to fall short by 20 to 25 percent".

"If proper analysis is done, there would be numerous other factors that could be responsible for the shortfall in meeting private sector growth target. I do not blame the hike in lending rates by banks alone as the only cause for slower credit. I feel the monetary policy is still not biting and therefore there is no monetary restraint on the system. You see there are no signs of slowdown in the corporate sector profit. GDP is still on the rise and likely to close only a whisker below 7 percent. Corporate earnings are attracting foreign investors, which is pushing our stock market to all time high."

The SBP identifies five major factors for the fall in private sector growth instead of high lending rates. First, the slow growth in capital expenditure (Plant and Machinery). Second, lending in the agriculture sector was down due to change in the lending policy of HBL. A couple of other banks are also reported to have restricted growth in agriculture sector portfolio due to technology constraints.

Third, ABN-Amro and Prime Commercial Bank were in merger talks, since almost one-year, hence, lending activity in their books thinned down. Also the merger between Standard Chartered and Union Bank, which after combining becomes one of the largest balance sheets in the country had gone into a consolidation phase contributing to slowing of monetary expansion. Both the banks went on the defensive.

Union Bank was then already in breach of SBP Advance/Lending Ratio (ADR), while SCB''s activity slowed down since it was in merger talks with the Union Bank. After the merger, SCB''s lending was badly choked, as ADR, as of Dec 2006, skyrocketed to 82.7 percent. The bank''s first quarter balance sheet suggests that during this period it was focusing to come within the limit and as of March 2007 its ADR stood at 74 percent. So from credit growth perspective, the activity was too slow.

Fourth dampening factor for slow credit expansion is the rise in the foreign exposure of some leading corporates in Pakistan, resulting in slowdown of domestic credit growth. Multinationals are borrowing dollars from overseas market and retiring their rupee loans therefore contracting local credit.

The fifth factor that may have given a blow to the national credit plan could be the delay in building power projects and dams. While announcing the private sector credit target of Rs 390 billion, these two factors were taken into consideration, but for some reason the projects have been delayed, says the Central Bank.

A risk manager of a foreign bank says banks with tighter control over their lending policy and with better risk management may not be willing to fund the equity market. He was quick to point to the recent decline of Chinese stock market, which however recovered quickly, as a good example of so-called "butterfly effect", the theoretical notion that a minor event in one location can lead to major consequences elsewhere.

"I am referring to SCRA investment in equities, which is hovering approximately around USD 1.6 billion (Stock Basis) inclusive of USD 719 million flow during the fiscal year," the banker added.

"From banks and regulators'' perspective there is a need for greater transparency in this area, as the financials don''t have the required data for transparency, which needs to be improved further," he said.

"Though in terms of governance and transparency, the country has come a long way, but still has a long way to go, if we take into consideration the international accounting rules, which require more improvement".

Market participants are finally feeling the presence of liquidity flush in Islamic banks in the interbank market. Deposits of Islamic banks surged to Rs 84 billion as of now versus February''s Rs 78 billion. Since their reserve requirement structure is different from the conventional banks and hardly any Shariah compliant market instruments are available, they are deploying liquidity in the interbank market as they have very few choices. This negates the Central Bank''s tight policy stance.

The lack of Shariah compliant sovereign instrument is also hampering monetary policy transmission mechanism to Islamic Banks. SBP mandates traditional commercial banks to maintain Statuary Liquid Requirement (SLR) at 18 percent and Cash Reserve Requirement (CRR) at 7 percent, whereas, Islamic Banks'' SLR requirement is 8 percent out of which 5 percent can be invested in Wapda (Sukuk) bonds and 3 percent cash is to be deposited with SBP at zero percent return. CRR requirement of Islamic banks is similar to conventional banks, CRR is 7 percent for short-term and 3 percent for any period beyond 6 months.

Overall perception is that if the average of the two rates comes to around 6 percent or if the short term and long term deposits of Islamic banks are split at 50 percent each, the effective CRR comes to 5 percent.

Islamic banks work differently, as they create assets and liabilities. They first generate Shariah compliant assets for financing and then generate deposits, ie first they have to book assets through capital and using the income stream, give shares or weights to each liability product, which generates returns for depositors.

The deposits of Islamic banks are on a constant rise, reflecting the desire of depositors to get Riba-free income. The size of Sukuk bonds available for the Islamic banks eligible for SLR purposes is estimated at around Rs 8-10 billion giving a yield of 8 to 9 percent. Even within the existing Sukuk float, some of the conventional commercial banks have invested, thereby further restricting the availability of these Sukuk bonds to Islamic banks.

Though the Islamic banks'' advance/deposit ratio stands at 77 percent, it is not easy to create Islamic assets. They do not have overdraft facility and personal loans scheme like other commercial banks. They have to conduct their business under Shariah compliance. Islamic banks are, therefore, in desperate need of Sukuk bonds and unless Rs 20 to Rs 30 billion bonds are floated, the non-interventionist position of SBP vis-a-vis Islamic banks will continue to bother SBP. Constituting only three percent of the total bank deposits, SBP awaits governmental action but the fast pace rise in deposits in these banks requires a degree of urgency on the part of the government.

Leading Islamic banks have opened accounts of smaller Islamic banks and offer profit in a range of 5 percent to 7 percent. They then lend those funds under Murabaha agreement. Such lending at cheaper rates is often contrary to Central Bank''s tighter monetary policy stance.

Presently it is estimated that against SLR requirement of 18 percent, commercial banks have government securities equivalent to 24 percent, yet they have more appetite to swallow the government securities. The market is keenly waiting for more Sukuk bonds.

Prime Minister Shaukat Aziz in his last visit to Karachi assured the bankers that the Islamic banks would soon hear the good news about how to deal with their excess liquidity problem through issuance of Sukuk. It is expected that the government would announce a sizeable amount of Karachi Shipyard Sukuk bonds and PIA Sukuk bonds, which would not only provide comfort to Islamic banks but would also help in draining excess funds from the banking system. Offering Sukuks in small chunks would make little difference and hence would continue to exert pressure on the rates.

Courtesy by  Business Recorder.


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